CNE Canaccord Genuity Update
Positioning for new gas contracts
Canacol reported relatively in-line year-end results. Adjusted quarterly funds from operations (i.e., including the Ecuador IPC and excluding cash interest expenses) came in at $8.5 million versus our $10.7 million estimate; variances related to inventory builds, operating and G&A costs and realized oil prices. Capital spending of $22.4 million (including Ecuador) was largely in line with our $20.2 million estimate.
One surprise was Canacol's 15% investment in Pacific Power Generation Company for $11.6 million. According to its website, Pacific Power is dedicated to the generation and sale of electricity in Colombia, Ecuador and Haiti. We believe Canacol made this strategic investment to help secure future gas contracts.
The company has entered the planning phase of a new gas pipeline project, with the aim of increasing gas sales by 100 MMcf/d in 2018. To that end, the 2016 budget is focused on gas exploration to potentially fill the new pipeline. While drilling is likely several months away, the $52 million program will target 100 Bcf of unrisked resource potential.
In the very near term, investors can look forward to Canacol's 90 MMcf/d gas ramp up over the next couple weeks.
• Production for the quarter came in at 8,887 boe/d, in line with our 8,858 boe/d estimate.
• Operating netbacks of $13.25/boe (excluding Ecuador) were slightly below our $14.70/boe estimate due to realized oil prices and higher-than-expected operating costs. During the quarter, the company was able to reduce per-barrel operating expenses even with a 29% reduction in oil volumes QoQ. Year-over-year, operating expenses have declined due to supplier negotiations, a weakening peso, and operating efficiencies.
• During the quarter, gas prices averaged $5.07/mcf, with realizations as high as $5.50/mcf at Clarinete. Based on current gas contracts, prices at Esperanza are expected to escalate from $4.75/mcf in 2015 to $6.60/mcf in 2017.
• Quarterly G&A expenses of $8.6 million were above our $4.8 million estimate, partly due to $1.7 million in severance costs. G&A reductions will remain a core focus in 2016.
• With a working capital surplus of $46 million and total debt $248 million, year-end net debt stood at $202 million. During the quarter, the company recorded a non-cash impairment of $44.6 million on its oil properties. Gas properties were unaffected.
Valuation and thesis
We maintain our BUY recommendation given Canacol's expected gas ramp-up, low cost asset base, and exploration upside potential. The company has very little exposure to global oil and gas prices, but trades at a discount to fixed commodity contracts (C$5.05/sh, with C$4.10/sh attributable to Colombian gas). Using a DCF model, we estimatea Base NAV of C$5.75, which we discount in establishing our C$5.00 target. Canacol currently trades at a 2016E EV/DACF multiple of 5.5x versus the peer average of 4.4x.